Part two of a 6-part series on new revenue recognition guidelines.
The core principle of the new guidelines is to recognize revenue to depict the transfer of promised goods or service to customers in an amount that reflects the consideration to which the entity expects to be entitled for those goods or services2. That is, the aim is to recognize revenue consistently as the customer assumes ownership of the various components of a contract, and values the revenue at that obligation’s appropriate share of the expected revenue.
Steps to achieve this core principle:
Establish the contract
with the customer
Identify the performance obligations
(promises / deliverables) in the contract
Determine the (overall) transaction price
the transaction price to the contract’s performance obligations
• Recognize revenue
as the reporting organization satisfies a performance obligationA Simple Example
Your organization sells a computer system and printer to a customer for $1,000. The computer and software are delivered to the customer in June but, due to manufacturing delays, the printer is delivered in July. Under the new Performance Obligation guidelines, when is the revenue for the various components of the contract to be recognized?
1. A contract is established for a computer system
2. Consisting of three performance obligations:
a. Laptop computer
The overall transaction price is $1,000
The company’s standalone selling prices are:
a. Laptop: $800
b. Printer: $200
c. Software: $200
Under the contract, then, the performance obligations are assigned transaction prices of:
a. Laptop: $1,000 / 1200 * 800 = $666.67
b. Printer: $1,000 / 1200 * 200 = $166.67
c. Software: $1,000 / 1200 * 200 = $166.67
Once either party has acted on the contract (i.e., at the earlier of the customer accepting an invoice or the vendor commencing shipping), the vendor accrues the liability to the customer for each performance obligation at the assigned revenue valuations.
Upon delivery of the laptop and software, the vendor recognizes $833.33 in June. At the end of June, the balance sheet shows an accrued liability to the customer of $166.67 for the printer. In July, when the client takes ownership of the printer, the vendor recognizes $166.67.
Do the new revenue recognition guidelines affect you? Part 3 of this series, “Who is Affected?” may help you answer that question.
Other articles in the New Revenue Recognition Guideline series can be reviewed by clicking the respective title: Part one: Like it or not, they’re on the way FAQs:
Part three: Who is affected?
Part four: What are the challenges for affected organizations?
Part five: What should I be doing?
Part six: How will Oracle’s experience help?
To learn more about Enterprise Performance Management, click here
Retrieved on March 9, 2016 from FASB web page: http://www.fasb.org/jsp/FASB/Page/BridgePage%26cid=1351027207987